Angels Get Carry For Helping A Startup Raise Money With AngelList Syndicates

AngelList is testing out a new service that lets angel investors syndicate deals with each other, a feature that could allow startups to raise venture-sized rounds of money with relative ease. Called Syndicates, the private-beta product lets any accredited investor on the AngelList fundraising platform essentially create, lead and collect carry for a fund of angel money for a specific startup.

The carry part could help motivate an angel who truly believes in the startup to put in the hard work of helping it raise all the money it thinks it needs. In a world where more startups than ever are trying to raise money, and more investors are competing to find the best ones, this model may quickly become popular.

Here’s a bit more about how it works, as gleaned from the newly-public FAQ from AngelList, the resulting conversation around the news on Twitter, and a conversation with AngelList cofounder Naval Ravikant. The news, we’ll note, was broken by anonymous startup personality Startup L. Jackson… who presumably has investor-level access to AngelList, whoever he or she is.

VCs and their limited partners (the entities who put money into VC funds) already use carry to align their interests. In addition to the VC partners collecting a set management fee for each fund, the carry provides them with a percentage of the profit for the fund.

In the AngelList implementation of the concept, the lead angel picks the percentage carry that they’ll get from a positive return in the company if it has a liquidity event. They can set this to zero, which would make the most sense if they’re relatively unknown and most concerned with building a reputation. Or they can set any amount above that — 40% could make sense, for example, if you’re a top angel and looking to monetize your reputation and deal flow.

The FAQ provides the following example of how a lead angel would use Syndicates:

Sara decides to invest in a startup and asks for a $250k allocation in the company. She personally takes $50K of the allocation and decides to syndicate the rest. She shares the deal with investors and specifies that she is charging a 20% carry on the remaining $200k of her allocation. Sara’s capital and her co-investor’s capital is pooled into a $250K fund which invests in the startup.

Sara’s co-investors pay carry for her access, governance and value-add. She sourced the deal and used her judgment to select the investment. She manages the fund and provides oversight for her co-investors’ capital. And she provides ongoing value-add to the startup.

AngelList takes 5% regardless, which makes Syndicates a potentially big revenue stream for the funding platform. It also sets each Syndicate up as an LLC specifically for the startup in question, with the lead angel signing off as an investment advisor. This legally obligates the angel to disclose any conflicts, such as other strategic or financial relationships with the startup.

As part of the service, AngelList also requires the lead to put up at least 10% of their own money into this vehicle, in contrast with the much lower percentages that LPs typically require of VC funds. In my discussion with Ravikant, he adds a few other points on how he sees Syndicates working.

“The backers are likely to be LPs, family offices [of the very wealthy], passive angels, and angels out of market who can’t get into a deal or don’t want to spend the time,” he explains. Meanwhile, the lead angel is expected to take this more seriously than some angels might be used to, in that they are expected to “provide access, oversight, and help the company.”

At the same time, he disputes the notion that Syndicates is competing against VCs here — an assumption one might make given that Syndicates could help a company raise a lot of money quickly. “This isn’t about ‘without VCs’ — in our test, anyone investing less than $100K per deal goes via Syndicates. Over that and you get a direct intro. If you’re putting in serious money, the company wants to meet you. The two will coexist.”

“In fact,” he adds, “some well known VCs have already approached us about syndicating deals — they wouldn’t take a carry, but would get advisory shares for being on the board and / or get to control syndicate allocations and voting. We are also talking to seed funds who want extra leverage.”

A less obvious benefit of the setup is that angels now have a new way to take advantage of pro rata terms. Typical deal terms already allow investors to continue putting money into a company in order to maintain their existing percentage, even as the company raises new funding at higher valuations. But, many angels do not want to raise or borrow the money to do this, so they forego the option. With Syndicates, the investor can fundraise to buy stock made available via pro rata terms, and collect carry on any resulting profit.

What about the murky world of finance law? Where does the Securities and Exchange Commission stand on this new method of raising money? AngelList has obtained a no-action letter from the federal agency, which means that it can launch the service without fear of its legal reprisal. You can view the PDF here.

But wait, how new is this concept? Finance writer Dan Primack notes that “fundless sponsors” already exist, and indeed they’ve become an increasingly common method for private equity investors to pool money in recent years.

There are very few instances of a carry-based LLC being used for angel investment, though. FundersClub, a relatively new investment-vehicle startup focused on raising funds around startups and startup categories, has also been pursuing it. Sequoia’s long-running “Scout” program is another, albeit at an intentionally smaller scale. To Ravikant, “[t]his is closer to Sequoia scouts than anything else. It allows anyone to be a scout, not just Sequoia’s CEOs, and anyone to be a backer, not just Sequoia. And it’s all carry-based (no fees).”

He adds that this is just a test for the next couple months. It may not work, or the implementation may change.

But any startup that needs funding and has an angel lined up is going to be looking at Syndicates hard as a new option. And the early-stage investment community is already busy trying to figure out the threats and opportunities.

Finally, the SEC, Congress and other government entities are currently changing the rules for private fundraising, which could make Syndicates explode in popularity. Private companies could soon be able to publicly advertise that they’re looking for money, which might help them benefit from the Syndicates concept immediately. And if non-accredited investors are allowed in, lots more money could start to flow through, too (and Startup L. Jackson will have a tougher time beating the tech press on AngelList scoops).